Archive - Jun 15, 2010 - Story

The primary indicator used by Jim Caron in his daily letter to assuage client fears about contagion, 3 month Libor, has taken a step for the worse. As Market News reports: "Dollar and euro 3-month LIBOR both rose Tuesday, with the dollar rate at its highest since July 6 last year and the euro rate at its highest since Dec 29 2009. The euro overnight LIBOR rate rose 32.13 basis points, due to the end of the European Central Bank maintenance period, while the 3-month LIBOR rate was up 0.19 points." Adding to increasing short term funding concerns was the fact that going forward the ECB will take a 5% haircut on all Greek bonds posted as collateral with the ECB. As this amount has surged recently, Greece will be now forced to post yet more bonds just to cover the spread. Luckily, Greece is allowed to post any collateral at all, as the once-prudent ECB now allows for any worthless collateral to be pledged for cash on its balance sheet. Very much like our own Fed. Lastly, yesterday's Greek downgrade by Moody's drew harsh criticism by Europe. As Reuters reports: "Moody's decision came at quite an astonishing and unfortunate moment" according to Olli Rehn, who added "the downgrade had not taken into account latest developments in Greece." On the other hand, seeing how much credibility (none) the Greek government has, after having been caught lying about its deficit for years, is this really a surprise?

A new to be released EU report warns that far more deficit cuts will be required. The report focuses on Spain and Portugal, and especially on the year 2011. According to the report a "snowball" effect may hit Spanish and Portuguese debt, and that the fiscalchallenges for the two countries are "daunting." And as the se kinds of reports tend to be self-fulfilling prophecies, Portuguese bonds have shot lower, and the spread to Bunds is +12.5 bps at the day's wides, or 271 bps. We anticipate many more such reports to come out about every country in Europe that has been forced to establish austerity measures, which basically means every country in Europe. And somehow the force is still strong with Keynesianism in the US, which is still deluding itself into believing it will be able to squeak through the cracks with no deficit cuts.

• Asian stocks reverse loss on recovery signs; bond risk falls.
• BoJ will make $32.8B of low-cost funds available to private banks to lend to companies.
• Brazil, China, and India to see strong growth in agriculture as output remains stagnant among big importers in Western Europe.
• China's Bank Regulator warns risks growing from real estate 'chain effect'.
• Euro down to $1.2182 in morning European trading due to Greek finance worries.
• Fed weighs options in case growth ebbs.

More imminent concerns of counterparty collateral calls: BP Plc’s long-term issuer default rating snd senior unsecured rating were cut to BBB from AA at Fitch Ratings. The rating watch was changed to Evolving from Negative. BP is now just barely investment grade to Fitch, the rating agency that has the highest Greek rating.

RANsquawk European Morning Briefing - Stocks, Bonds, FX etc. – 15/06/10

Some late night words of caution from one of the UK's best journalists. In a report obtained by Ambrose Evans-Pritchard, French financial firm AXA is quoted as essentially saying that the chance of the Eurozone's survival is nil. Why a European bank would issue it own suicide note is unclear, although the firm's logic is sound: "The markets are very nervous because they can see that there is a fatal
flaw in the system and no clear way out. We are in a very major crisis that has even broader implications than
the credit crisis two years ago. The politicians have not yet twigged to
this." Ms Zemek said the rescue had bought a "maximum" of 18 months respite
before deeper structural damage hits home, with a "probable"
default by Greece setting off a chain reaction across Southern Europe. "It
would be the end of the euro as we know it. The long-term implications are
at best a split in the eurozone, at worst the destruction of the euro. It is
not going to end happily however you slice it."

Zero Hedge has long contended that risk models based on VaR "predictions" are flawed and only add to systemic instability due to the ever increasing correlations across all asset classes. We now read a first hand mea culpa from Morgan Stanley's Jim Caron, in which the head of the firm's rates strategy highlights precisely this problem: the complete collapse of predictive models when multiple sigma events like the May Flash Crash and the accelerating sovereign collapse of the past several months occurs: "April and May were difficult months for us and others, judging by fund data on market performance. We did not properly discount the risks associated with peripheral Europe. As a result, we had a larger risk exposure than we should have. We measure the return potential for our positions on a per-unit-of-risk basis, similar to a Sharpe Ratio. That unit of risk turned out to be much higher than we anticipated. This will force us, and many others, to right-size our risks." We wish we could agree with the last statement. Alas, each and every risk management group at comparable prop trading desks (to that of Morgan Stanley), will undoubtedly chalk off recent events to chance, and as these "will never recur", business we will promptly return back to normal, until we see another record crash in the Dow, only this time not 1,000 but multiples thereof.